Five Ways To Escape The Crypto Bear Market In One Piece

Five Ways To Escape The Crypto Bear Market In One Piece
Reda Farran, CFA

about 2 years ago7 mins

  • We could be headed for a crypto bear market, and one way to protect your portfolio against a big crash is by purchasing out of the money put options on bitcoin or ether.

  • You can also remain invested in crypto but shift your holdings away from high-risk coins and toward bitcoin and ether, or toward stablecoins with attractive yields.

  • Finally, you can also try to hedge your portfolio by shorting a crypto index fund or Coinbase’s stock, but just note that these are proxy hedges and not perfect hedges.

We could be headed for a crypto bear market, and one way to protect your portfolio against a big crash is by purchasing out of the money put options on bitcoin or ether.

You can also remain invested in crypto but shift your holdings away from high-risk coins and toward bitcoin and ether, or toward stablecoins with attractive yields.

Finally, you can also try to hedge your portfolio by shorting a crypto index fund or Coinbase’s stock, but just note that these are proxy hedges and not perfect hedges.

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There’s been a massive selloff in the crypto sector in 2022 so far, with bitcoin down by more than a third from the all-time high it hit around two months ago. Now, you could HODL and ride this potential bear market out, or you could take some measures to protect your portfolio in case things go from bad to worse. Here are five ways to do just that.

Strategy 1: Take a “flight to quality”

The easiest change you can make to your portfolio during a bear market is what’s called a flight to quality: moving your money from risky investments to less risky ones. In the crypto world, that means moving money out of unproven projects, memecoins, and other high-risk coins that could get crushed in a bear market, and toward bitcoin and ether instead.

Why these two? Well, bitcoin is the best store of value, and ether powers the best global computing platform. They both have long, established histories and they’re the two biggest coins by market capitalization. They’re also seeing increasing demand from institutional investors like big financial firms. For all those reasons (and more), many investors tend to flock to these two coins during crypto bear markets, which helps them outperform other corners of the crypto market.

There are two pros to this option: it’s simple to implement, and you’ll capture plenty of the upside if crypto markets rebound. The main con is that the portfolio remains fully invested in crypto, which means it’s fully exposed to falling prices. What’s more, this option is harder and costlier to implement if your coins are spread across many different wallets or are locked up (if, for example, you’re staking them).

Strategy 2: Hedge your portfolio

Let’s say you want to sell your crypto and move into cash, but your coins are spread across many different wallets or locked up. In that case, it can be quite costly or (if the coins are being staked) outright impossible to sell them. But what you can do instead is hedge your portfolio by shorting an equivalent dollar amount of a crypto index fund.

For example, if you have $5,000 invested in crypto, you could short $5,000 worth of the Bitwise 10 Crypto Index Fund (ticker: BITW). This fund tracks an index comprised of the 10 biggest cryptocurrencies, making it a good representation of the overall crypto market. And gains from shorting BITW during a bear market can help offset losses from your crypto holdings.

This strategy also has another advantage See, when crypto sentiment is deteriorating, BITW’s market value could trade at an increasingly deep discount to the net asset value (NAV) of its underlying holdings. That’s because, unlike an ETF with mechanisms that ensure its price perfectly tracks its underlying holdings, BITW’s share price is mainly determined by supply and demand – the latter of which takes a big hit during bear markets. So let’s say the value of BITW’s 10 crypto holdings declines by 30%: BITW’s share price could, for example, decline by 35%, further boosting a short seller’s gains.

The pros of this option are threefold: it’s relatively easy to implement, it hedges your portfolio’s crypto exposure without forcing you to actually sell any of your crypto, and it can lead to boosted gains during a bear market that deepens BITW’s discount to NAV. The main con of this option is that it's a proxy hedge, not a perfect one. That is, BITW’s 10 crypto holdings could be very different to your own holdings, and therefore a short position in BITW won’t move inversely to your crypto portfolio in a perfect one-to-one fashion.

Strategy 3: Move to stablecoins with attractive yields

In bear markets, cash is king. Even better if you can put that cash to work to generate attractive yields while you wait to buy back into a recovering market. So instead of moving all your holdings to cash in the form of fiat, you can move them to stablecoins and put them to work. A simple example is buying USDC or DIA and then depositing them in decentralized finance (DeFi) lending platforms like Compound or Aave to earn some interest (currently around 3% per year).

You can also hold your stablecoins in centralized finance (CeFi) platforms like Celsius which pays a flat 8.5% interest rate on several stablecoins like USDT, USDC, and BUSD. This is still considered relatively safe, with the main risk being that something goes wrong at the CeFi platform – like a hack. That’s why it’s best to spread your stablecoins across a mix of different DeFi and CeFi platforms, and only well-established ones with good reputations. Here’s a great resource to see the latest interest rates on different stablecoins across both DeFi and CeFi platforms.

The main pros of this option are that you’re not exposed to falling crypto prices, and you can still generate stable and relatively attractive returns even during a bear market. The main con is that you’d have to swap all your existing coins for stablecoins, which can lead to high costs in the form of trading fees and price slippage.

Strategy 4: Buy some insurance

One way to protect against a big fall in the crypto market is by purchasing out-of-the-money put options. For an upfront fee (called the option “premium”), put options give you the right to sell the underlying coin at a certain price, setting you up to profit if its price falls. And by out of the money, I mean a put option with a strike price well below the coin’s current price. That way you pay less for the option premium (but the flipside is that you’re only protected against big crashes).

The payoff profile here is similar to buying any kind of insurance: you stand to make big gains in the event of a crash, but you lose the entire option premium if crypto markets end up going sideways or rebounding. So the option premium here is like an insurance premium: the cost you have to pay for crash protection.

Exchanges that offer options (mainly on bitcoin and ether) include Deribit, LedgerX, OKEx, CME, FTX, and Bit. Alternatively, if you don’t want to open a new account at another exchange, you can also use your everyday stock trading account to buy put options on bitcoin ETFs like the ProShares Bitcoin Strategy ETF (ticker: BITO).

The pros of this option are that it can protect your portfolio against a big crash and that you don’t have to actually sell any of your crypto. The main con is that put options on highly volatile crypto can still be quite expensive, and you can lose the entire premium paid if crypto markets end up going sideways or rebounding. Also, investing in options requires technical knowledge and a more hands-on approach.

Strategy 5: Short Coinbase’s stock

Coinbase earns most of its revenue from charging commission fees on trading, mainly among retail customers. Interest in crypto from these customers – and therefore their trading activity – moves hand in hand with the overall crypto market. So a lasting fall in crypto prices would be a major blow to Coinbase’s revenue and, in turn, its stock price. In fact, its stock price has moved alongside bitcoin’s price ever since the company went public.

Coinbase’s stock price (white line) moves in-sync with bitcoin’s price (blue line). Image source: Bloomberg Terminal
Coinbase’s stock price (white line) moves in-sync with bitcoin’s price (blue line). Image source: Bloomberg Terminal

On top of the prospect of a crypto winter, Coinbase is facing intense competition not only from other exchanges (like Binance, Kraken, and FTX), but also fintech firms (like Revolut), and payment apps (like Paypal and Square). Battling for customers in such an environment could negatively impact Coinbase’s revenue growth and profit margin, especially considering that it charges higher fees than other exchanges, making it more likely that customers will defect to cheaper alternatives.

The main pros of this option are that it’s simple and easy to implement and doesn’t require you to actually sell any of your crypto. The main con of this option is that it's a proxy hedge, not a perfect one. That is, a short position in Coinbase will most likely not move inversely to your crypto portfolio in a perfect one-to-one fashion. Also, you could lose money by shorting the stock even if we enter a bear market but there’s some positive event – like a strong earnings update or a potential acquisition of the company – that causes its price to soar.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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